Seminar 
                          2 
                      Theory of 
                      Ecosystem 
                       Services 
                         Speaker 
                       Dr. Stephen Polasky 
                  
                 Valuing Nature: Economics, Ecosystem 
                 Services, and Decision-Making 
                 by Dr. Stephen Polasky, University of Minnesota 
                 INTRODUCTION 
                 The past hundred years have seen major transformations in human and ecological systems. There has been a rapid rise in economic 
                 activity, with a tenfold increase in the real value of global gross domestic product (GDP) (DeLong 2003). At the same time, the Millennium 
                 Ecosystem Assessment found many negative environmental trends leading to declines in a majority of ecosystem services (Millennium 
                 Ecosystem Assessment 2005). A major reason for the rapid increase in the production of goods and services in the economy and 
                 deterioration in the provision of many ecosystem services is the fact that market economic systems reward production of commodities 
                 that are sold in markets and accounted for in GDP, but does not penalize anyone directly for environmental degradation that leads to a 
                 reduction in ecosystem services. As Kinzig et al. (2011) recently wrote about ecosystem services: “you get what you pay for” (or, 
                 alternatively, you don’t get what you don’t pay for).  
                  
                 Ecosystems provide a wide array of goods and services of value to people, called ecosystem services. Though ecosystem services are 
                 valuable, most often no one actually pays for their provision. Ecosystem services often are invisible to decision-makers whose decisions 
                 have important impacts on the environment. Because of this, decision-makers tend to ignore the impact of their decisions on the 
                 provision of ecosystem services. Such distortions in decision-making can result in excessive degradation of ecosystem functions and 
                 reductions in the provision of ecosystem services, making human society and the environment poorer as a consequence. Unless we fix 
                 this imbalance and begin to properly account for ecosystem services, and provide proper incentives for their sustainable provision, global 
                 society is unlikely to see the type of fundamental change necessary to sustain environmental quality, ecosystem services, and human 
                 well-being. 
                        
                 The question is how to remedy this situation and make ecosystem services visible to decision-makers. How can we “mainstream” 
                 ecosystem services so that individuals, businesses, and government agencies factor in the impact their decisions have on ecosystem 
                 services? In principle, the answer is easy; it lies in providing incentives for people to provide services, either through programs that 
                 provide payments for ecosystem services, or through taxes on actions that lead to environmental degradation, or by directly regulating 
                 activities that affect ecosystem service provision. In practice, there are numerous scientific uncertainties about the impact of choices on 
                 the provision of ecosystem services, economic uncertainties about the relative values of services, and institutional and policy design 
                 considerations. The three main tasks that must be performed in order to successfully mainstream ecosystem services are to: 
                  
                 1)    Link actions to impacts on the provision of services: improve understanding of the likely consequences of human actions on 
                       ecosystem processes and of their ultimate impacts on the natural capital that sustains ecosystem services 
                 2)    Value services: improve understanding of the contribution of ecosystem services to human well-being 
                 3)    Provide incentives: incorporate an understanding of the value of ecosystem services into policy and management frameworks, to 
                       provide incentives for the continued provision of valuable ecosystem services 
                   
                 Accomplishing these three tasks requires a better understanding of the natural science involved, better economic analysis, and better 
                 integration of science and policy. In some respects these tasks represent a tall order, and it may not be possible to be successful in all 
                 situations. But in many cases the policy tools and scientific knowledge are already in place. Doing a much better job than is currently 
                 being done is simply a matter of deciding that mainstreaming ecosystem services is a high priority. This white paper provides a brief 
                 review of the policy mechanisms, science, and economics relevant to the sustainable provision of ecosystem services. It provides 
                 examples of the use of InVEST (Integrated Valuation of Ecosystem Services and Tradeoffs) to evaluate the provision and value of multiple 
                 ecosystem services provided by landscapes under alternative policy scenarios.  
                  
                 There are a growing number of examples at both local and national scales of policies that provide incentives for the provision of 
                 ecosystem services. In the U.S., agricultural programs like the Conservation Reserve Program pay farmers to take land out of active crop 
                 production and plant perennial vegetation in order to reduce soil erosion, improve water quality, and provide habitat and other 
                 ecosystem services. Similarly, China’s Grain for Green program pays farmers to take steeply sloping lands out of production to provide a 
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               range of ecosystem services. Costa Rica’s Pago de Servicios Ambientales pays landowners for carbon sequestration and to protect water 
               quality, biodiversity, and scenic beauty. 
                
               At the local level, numerous municipalities provide payments to protect watersheds that supply drinking water. The success of an early 
               program in Quito, Ecuador, that collects a small surcharge on water users to protect and restore watersheds has led to the rapid spread 
               of “water funds” throughout Latin America. Private companies are also looking at how ecosystem services affect their bottom line. Dow 
               Chemical Company and The Nature Conservancy have embarked on a joint project to assess the value of ecosystem services to Dow and 
               surrounding communities. 
                
               Some conservationists and natural scientists have expressed grave doubts about “valuing nature” and ecosystem services, as well as the 
               role of economics and economists in conservation and environmental policy. Some scientists have complained that economists pay 
               almost no attention to biological or physical constraints (Hall et al. 2000), and that economists are hooked on growth and therefore 
               enemies of conservation and the environment (Czech 2000). Others have argued that working with economists to value nature is either 
               distracting or dangerous, because it plays into the hands of business interests and takes away from the strong moral arguments for 
               conservation (e.g., Ehrenfeld 1988; McCauley 2006). But most conservationists and natural scientists realize that engaging with 
               economists to demonstrate the value of nature, and how ecosystem services contribute to human well-being, can provide powerful 
               arguments for the conservation of nature (Daily 1997; Millennium Ecosystem Assessment 2005). In fact, continuing to put no value on 
               ecosystem services will likely continue the pattern of overexploitation and environmental degradation that we have witnessed in the 
               20th century.  
                
               Many economists, including several who are high-profile, such as Nobel laureate Ken Arrow (Arrow et al. 1995, 2004) and Sir Partha 
               Dasgupta (Dasgupta 2001), have applied economics to environmental issues and have developed economic tools and methods applicable 
               to addressing the value of nature. Economics is an essential component of efforts to measure the provision and value of ecosystem 
               services, and to understanding how mechanisms to mainstream ecosystem services are likely to work in practice. A fully developed 
               economics should routinely incorporate the value of ecosystem services into its analyses. It is bad economics as well as bad policy not to 
               account for the value of nature. 
               HISTORICAL AND METHODOLOGICAL FOUNDATIONS OF 
               ECOSYSTEM SERVICES
                                                              
               Though the term ecosystem services is fairly new — among the first uses appears to be Ehrlich and Mooney (1983) — the idea is quite 
               old. Throughout most of human history, it was probably so obvious that nature contributed to human well-being as to be totally 
               unremarkable. Both hunter-gatherer societies and agricultural societies are clearly tied to the functioning of ecological systems, even if 
               these systems are heavily modified in agro-ecosystems. It is only with increasing wealth, supporting specialization and the rise of urban 
               populations, that the most obvious ties to nature have been cut. And though we might like to think that overpopulation, pollution, and 
               the overuse of resources are modern problems, concerns about them go back at least to the Greeks and Romans, if not before. For 
               example, the following quote is from Roman times: 
                
                        “…farms obliterate empty places, ploughed fields vanquish forests, sandy places are planted with crops, stones are fixed, 
                        swamps drained…. The resources are scarcely adequate to us; and our needs straiten us and complaints are everywhere while 
                        already nature does not sustain us.” — Quintus Septimus Florence Tertillianus 200 AD (quoted in Johnson 2000).  
                     
               Concerns about human demands exceeding what nature could supply are present in some the first contributions by economists. Thomas 
               Malthus famously wrote that population, when unchecked, grows geometrically, while food supply grows arithmetically, so that 
               eventually demand for resources outstrips their supply. According to Malthus, starvation and disease would ultimately check human 
               population. For such thinking, economics gained distinction as “the dismal science.” Another early economist, David Ricardo, derived the 
               theory of rent and diminishing returns by observing that the best agricultural land would be utilized first and that further expansions of 
               agriculture would be forced to use less productive land. 
                
               Much of the theory underlying modern economic thinking about the environment was developed in the 19th and early 20th centuries. 
               Optimal use of natural resources has been a recurring theme in economics. Martin Faustmann solved the problem of the optimal rotation 
               age for timber harvests in 1849. Harold Hotelling described the optimal use of exhaustible resources such as oil or mineral deposits 
               (1931). Perhaps the most important advance for understanding the problem of providing incentives to preserve ecosystem services came 
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               from British economist A.C. Pigou (1920) who developed the notion of externalities, where the actions of one individual or firm directly 
               impact the welfare of other individuals or firms. 
                
               Negative externalities involve actions by one party that directly harm other parties, like emitting pollution, but for which the first party 
               pays no cost. Positive externalities involve cases where the actions of one party directly benefit other parties, but the first party receives 
               no payment. Unless some type of corrective policy is undertaken to “internalize” the externality, too many negative externalities and too 
               few positive externalities will occur. Pigou recommended that actions generating negative externalities be taxed (now called Pigouvian 
               taxes) and actions generating positive externalities be subsidized. Payments for ecosystem services can be thought of as one form of 
               Pigouvian subsidy. 
                
               Currently there is a vast body of work by economists relevant for thinking about the value of ecosystem services. Much of this work lies in 
               the fields of environmental economics, natural resource economics, and ecological economics. Environmental economics builds on the 
               Pigou's insights to analyze problems caused by externalities and public goods. Public goods are “non-rival” (one person’s enjoyment of 
               the good does not diminish the ability of others to enjoy the good) and “non-excludable” (if the good is available for one it is available for 
               all). Many ecosystem services are public goods — for example, water purification or climate regulation services. Public goods are typically 
               under-provided because there is an incentive to free-ride: why pay to provide a public good when you can freely enjoy the good provided 
               by others?  
                
               Environmental economists have also developed a range of policy approaches to internalize externalities and provide incentives for the 
               provision of public goods, including payments for ecosystem services, taxes on pollution and other negative externality–generating 
               activities, and cap-and-trade systems, which limit the overall level of a negative externality–generating activity but allow entities to trade 
               permits that entitle them to engage in that activity. This topic is by now quite well developed, with many textbooks describing alternative 
               policy mechanisms that could be applied to internalize externalities and provide public goods (e.g., Hanley et al. 1997; Tietenberg and 
               Lewis 2009). 
                
               In addition, environmental economists have developed methods of nonmarket valuation. Most ecosystem services are not traded in 
               markets and so have no market prices to act as a signal of value. Nonmarket valuation uses observed behavior, such as how much more 
               people pay for houses near environmental amenities, where they travel for outdoor recreation, and responses to survey questions, to 
               gauge the value that people place on environmental quality or other aspects of nature. Nonmarket valuation began to be applied to what 
               we would now call ecosystem services in the 1960s and 1970s, in work centered at Resources for the Future (Krutilla 1967; Krutilla and 
               Fisher 1975). 
                
               Natural resource economics and ecological economics address sets of issues related to human–nature interactions and sustainability. 
               Natural resource economics analyzes the use of renewable and exhaustible resources, and has been applied to analyze other “resources,” 
               including aspects of nature (species, habitats, natural beauty), that are important for recreational and spiritual or cultural reasons. 
               Reflecting this, some economists have begun to use the term “ecosystem services” rather than “natural resources” to discuss the broad 
               set of ecosystem contributions to the generation of benefits for people. Natural resource economics is useful for those interested in 
               ecosystem services because it has developed integrated bioeconomic models, particularly for fisheries, that help link ecological 
               conditions with provision of services. Such models are also useful for analyzing the sustainable provision of services, and how 
               overharvesting or degrading natural capital would lead to a lower supply of services in the future. These models laid the groundwork for 
               the “ecological production functions” used in ecosystem service models. 
                
               The central theme of ecological economics revolves around sustainability and the long-term evolution of social-economic-ecological 
               systems. Ecological economists have long called for the integration of economics with ecology and other natural sciences to better 
               understand ecosystem services and the life-support system provided by the biosphere (Costanza 1991). Ecological economists have also 
               called for a broader dialog between economists and other social scientists to better understand the many contributions of nature to 
               human well-being. Ecological economists have produced many ecosystem service assessments, including relatively early work on the 
               value of wetlands (e.g., Farber and Costanza 1987) and a widely cited but highly controversial effort that estimated the value of Earth’s 
               ecosystems at US $33 trillion per year (Costanza et al. 1997). Economist Mike Toman characterized the valuation of US $33 trillion for 
               Earth's life-support system as “a serious underestimate of infinity” (Toman 1998). 
                
               Over the past few years there has been an explosion of interest in ecosystem services. The 2005 publication of the Millennium Ecosystem 
               Assessment, which made ecosystem services its central focus, prompted a chain of efforts to address ecosystem services. Major recent 
               studies include Valuing Ecosystem Services: Towards Better Environmental Decision-making (National Research Council 2005), Valuing the 
               Protection of Ecological Systems and Services (U.S. Environmental Protection Agency Science Advisory Board 2009), The Economics of 
               Ecosystems and Biodiversity: Mainstreaming the Economics of Nature (TEEB 2010), Natural Capital: Theory and Practice of Mapping 
               Ecosystem Services (Kareiva et al. 2011), and the U.K. National Ecosystem Assessment (2011). All of these efforts blend economics with 
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